I am a huge proponent of the three-fund portfolio for investing. In fact, my asset allocation matches that of the Fidelity target-date funds. So why not keep it simple and just buy the Fidelity target-date fund?

An Example

Consider the example of a 32-year old new attending who is planning to retire at age 65 (2050). Following my philosophy of using passive index funds, they consider purchasing the Vanguard Target Retirement 2050 Fund (VFIFX). This has an expense ratio of 0.16%, with the following holdings (and expense ratios for the underlying funds):

Index FundAllocationExpense Ratio
Vanguard Total Stock Market Index Fund Investor Shares54.3%0.05%
Vanguard Total International Stock Index Fund Investor Shares35.6%0.12%
Vanguard Total Bond Market II Index Fund Investor Shares7.1%0.06%
Vanguard Total International Bond Index Fund Investor Shares3.0%0.14%

For simplicity, I would lump the Total Bond Market II Index Fund and the Total International Bond Index Fund into one bond fund, since it is such a small allocation. The portfolio of individual index funds would have an expense ratio of 0.08%. So by holding 3 funds instead of one, you save 0.08% in expenses per year. While this may seem minuscule, especially for a small portfolio, this makes a big difference in the long-run, and can potentially significantly boost your returns.

Assuming an average return of 7% for the three-fund portfolio and 6.92% for the target-date fund, a $100,000 portfolio today would grow to $932,534 in retirement using the three-fund portfolio, compared to $909,799 using the target-date fund. This is a difference of $22,735, or 23% of your original investment. Not a small amount for having to manage three funds instead of one.

There are additional benefits to the three-fund portfolio over the target-date fund, including more opportunities to harvest tax losses, the ability to properly allocate your investments between tax-protected and taxable accounts, and the option to customize your three-fund portfolio to your personal tastes.

What about rebalancing?

In my opinion, rebalancing is not required to be done more than annually for an index fund investor. For the resident and early or mid-career attending, rebalancing should always be done with new money. Since you’ll be putting in new money that you’ve saved into your portfolio every few months anyway, why not just put the money into the appropriate index fund that gives you the target-date fund allocation?

Remember, you should avoid selling any index funds to rebalance. If you sell index funds for a profit in a taxable account, you will need to pay capital gains taxes on it, which could blunt the benefits of compounding, since those taxes will be in Uncle Sam’s pocket instead of in your portfolio making more money for you.

Tax Loss Harvesting

Having multiple index funds allows additional opportunities for tax loss harvesting. You would potentially be able to tax loss harvest from three or four different index funds. Since the point of the index fund portfolio is to increase diversification, it is not uncommon for one index fund to be up, while the other is down, despite the overall portfolio or target-date fund being up.

Asset Location

While the benefits of asset location are limited, especially in a low interest rate environment, in general, you want to put tax-inefficient index funds (i.e. bonds) in your tax-protected accounts, while putting your tax-efficient index funds (i.e. stocks) in your taxable account. This is possible only when you use a three-fund portfolio, instead of the single target-date fund portfolio.


By having a three-fund portfolio, you enable yourself to customize your portfolio in ways that are not available with target-date funds. Remember that you are not required to use the target-date fund that corresponds with your projected retirement age; your risk tolerance may be higher or lower than that. In that case, you can use a target-date fund that fits your desired asset allocation.

But if you desire a more customized asset allocation than what is offered by target-date funds, you will need to use a three-fund portfolio. For a three-fund portfolio, this primarily the decision regarding domestic and international stock allocation. Fidelity and Vanguard use approximately a 70/30 or 60/40 domestic/international exposure, but some highly respected investors have argued from as little as a 0% (e.g. John Bogle), to as much as a 50% (market weight) international allocation.

When Should Physicians Use a Target-Date Fund?

1. You have a small portfolio or individual account (e.g. HSA, 529)

If you have a small portfolio, the difference in expense ratios often is trivial. 0.08% on a $10,000 account is $8 a year. This is hardly worth the effort of managing multiple funds. This is part of my general recommendation that the complexity of your portfolio should increase as your net worth rises. Residents and young attendings are best off with a target-date fund (in their tax-protected accounts), young and mid-career attendings could be best served with a three-fund portfolio, and attendings near retirement can consider additional asset classes if they want the additional (small) benefits of these asset classes.

2. You hate looking at your investments

A target-date fund is like a poor man’s financial advisor: with one click, the target-date fund will give you a diversified portfolio, rebalance for you, and ensure you stay the course (if you don’t sell your target-date fund and try to go to cash). All of this for 0.08%. I think this is definitely worth it if you are a hands-off investor. It is certainly cheaper than having a “money guy” who will do many of the same things, but charge 1 or 2% of your portfolio.

3. You fear being undisciplined

This is the double-edged sword of customization — if you are a new investor and did not experience the 2000 or 2008 crashes, you only have experienced a bull market. By using a three-fund portfolio, there’s a danger that you will use your flexibility to be very aggressive in bull markets, but then become very conservative in bear markets. If you are unsure about your risk tolerance and your ability to stay the course in bear markets, consider a target-date fund.

Do you invest in a target-date fund or three-fund portfolio? Let me know in the comments below!


  1. I would prefer the 3-fund portfolio over a target date fund. I did TGF’s for a few years in my 401k but the expense ratios was almost double that of an S&P 500 fund and I actually do enjoy being hands on. So switching to index funds (currently just VTSAX) was an easy decision.

  2. What if the 401k plan has Vanguard Target Date Funds with an extremely low expense ration? Say 0.06? Would then using a TDF be a better idea than a three fund portfolio?


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